What a ‘Super Tuesday’ it was. The budget was released, both ANZ and Woolworths announced their company results and the RBA dropped interest rates to a historic low. The RBA has now followed a raft of countries into a low interest rate environment, by lowering the cash rate from 2 per cent to 1.75 per cent. Does this mean the RBA thinks the Australian economy is in trouble? Why the rate cut?

Low Inflation Environment

The RBA appeared to be somewhat surprised with the 0.2 per cent fall in the consumer price index in the March quarter. A student in Perth might welcome a drop in the price of their cup of coffee, but falling prices are definitely not well received by the RBA. The crux of deflating prices is low wage growth, so although your cup of coffee may cost less, you are also being paid less. The RBA’s target for inflation is between 2 -3 per cent, so the RBA is clearly unhappy with an underlying inflation rate of 1.55 per cent, which is the lowest since 1983. Lowering the cash rate should put a stop to any further deflation, and stimulate price growth.

Strength of the Dollar

In theory exchange rate stability is not an objective of the RBA, but in practice the RBA does consider the impact of changes in the cash rate on the Australian Dollar. Exchange rates and interest rates have a direct relationship; this means that when the interest rate is cut, the exchange rate will also fall. The Australian Dollar has sharply rebounded since mid January and now sits at around 0.75 US cents. The Australian economy is in a state of continuous rebalance, following the end of the mining boom. Sectors such as tourism, education and services are of increasing importance, and a high Australian Dollar means these sectors become less competitive on the global stage. For example international students have to pay more for university degrees, and holidaying here becomes more expensive for foreigners. As a result the RBA seeks to limit the appreciation of the Australian Dollar in order to maintain growth in these non-mining sectors.

Housing Market

The so-called ‘housing bubbles’ in Sydney and parts of Melbourne are now less of a concern than they were in mid 2015. Sydney’s annual housing price growth has fallen to 8.9 per cent, as compared to a peak of 18.4 per cent last July. Further Glenn Stevens, the Governor of the RBA, outlined that the RBA was satisfied that regulatory actions to strengthen lending standards were working. In particular the Australian Prudential Regulation Authority (APRA) have put a 10 per cent growth cap on bank’s home lending to investors. This combination of abated housing price growth and increased regulation has provided the RBA with scope to cut interest rates, without worrying too much about re-inflating the housing market.

Global Outlook

There continues to be significant uncertainty surrounding the global economic outlook and policy settings around the world. Global growth forecasts have been continuously downgraded, and China’s growth slowed to a 25 year low last year. The RBA has not expressed any confidence in the future long-term growth in China, which further emphasises the need for the diversification of the Australian economy. Emerging markets, such as Russia and Brazil, are experiencing deep recessions.

Despite subdued global economic growth, low inflation, moderate housing price growth and a recent higher Australian Dollar the RBA does not necessarily think the Australian economy has slumped. The rate of unemployment has hit a six month low of 5.7 per cent in March, and GDP grew at a steady rate of 3 per cent last year. There is no doubt the economy is re-adjusting to the end of the mining boom, and this rate cut should provide a helping hand to the upcoming services sectors. Let’s hope that this rate cut also provides consumers and businesses with the extra confidence they need and that this voyage into unchartered territory pays off.

Last Thursday the Federal Reserve decided to keep its short-term interest rates unchanged, a decision that saw a steep decline in the U.S. stock market. Although the prolonged period of expansionary monetary policy has greatly contributed to the recovering U.S. economy, investors interpreted the decision as a sign that the U.S. is still weak and vulnerable to international economic influences such as the devaluation of the Chinese currency. The decision has greatly contributed to the overall market uncertainly and the sentiment is now strongly positioned towards the interest rates not being raised until 2016.

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